Credit derivatives, the liquidity of bank assets and banking stability
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Authors
Wagner, Wolf
Publication Date
2005Series
CFAP Working Paper
18
Publisher
CFAP, Cambridge Judge Business School, University of Cambridge
Language
English
Type
Working Paper
Metadata
Show full item recordCitation
Wagner, W. (2005). Credit derivatives, the liquidity of bank assets and banking stability. http://www.dspace.cam.ac.uk/handle/1810/225165
Abstract
The emerging markets for credit derivatives have improved the liquidity of bank assets by providing banks with various new possibilities for selling and hedging their risks. This paper examines the consequences for banking stability.
In a simple model where liquidation of bank assets is costly, we show that increased asset liquidity benefits stability by encouraging a representative bank to reduce the risks on its balance sheet. Stability is further enhanced because the bank can now liquidate assets in a crisis more easily. However, we find that these stability effects are counteracted by increased risk-taking by the bank. Overall, stability actually falls because the improved possibilities for liquidating assets in a crisis make a crisis less costly for the bank. The bank therefore takes on an amount of risk that more than offsets the initial positive impact on stability.
Keywords
financial innovation, credit derivatives, risk taking, bank default
Identifiers
This record's URL: http://www.dspace.cam.ac.uk/handle/1810/225165